Copyright©2004 South-Western 18 The Markets for the Factors of Production

Copyright © 2004 South-Western The Markets for the Factors of Production Factors of production are the inputs used to produce goods and services.

Copyright © 2004 South-Western The Market for the Factors of Production The demand for a factor of production is a derived demand. A firm’s demand for a factor of production is derived from its decision to supply a good in another market.

Copyright © 2004 South-Western THE DEMAND FOR LABOR Labor markets, like other markets in the economy, are governed by the forces of supply and demand.

Figure 1 The Versatility of Supply and Demand Copyright©2003 Southwestern/Thomson Learning Quantity of Apples 0 Price of Apples Demand Supply Demand Supply Quantity of Apple Pickers 0 Wage of Apple Pickers (a) The Market for Apples(b) The Market for Apple Pickers P QL W

Copyright © 2004 South-Western THE DEMAND FOR LABOR Most labor services, rather than being final goods ready to be enjoyed by consumers, are inputs into the production of other goods.

Copyright © 2004 South-Western The Production Function and the Marginal Product of Labor The production function illustrates the relationship between the quantity of inputs used and the quantity of output of a good.

Table 1 How the Competitive Firm Decides How Much Labor to Hire Copyright©2004 South-Western

Figure 2 The Production Function Copyright©2003 Southwestern/Thomson Learning Production function Quantity of Apple Pickers 0 Quantity of Apples

Copyright © 2004 South-Western The Production Function and the Marginal Product of Labor The marginal product of labor is the increase in the amount of output from an additional unit of labor. MP L =  Q/  L MP L = (Q 2 – Q 1 )/(L 2 – L 1 )

Copyright © 2004 South-Western The Production Function and the Marginal Product of Labor Diminishing Marginal Product of Labor As the number of workers increases, the marginal product of labor declines. As more and more workers are hired, each additional worker contributes less to production than the prior one. The production function becomes flatter as the number of workers rises. This property is called diminishing marginal product.

Copyright © 2004 South-Western The Production Function and the Marginal Product of Labor Diminishing marginal product refers to the property whereby the marginal product of an input declines as the quantity of the input increases.

Figure 2 The Production Function Copyright©2003 Southwestern/Thomson Learning Production function Quantity of Apple Pickers 0 Quantity of Apples

Copyright © 2004 South-Western The Value of the Marginal Product and the Demand for Labor The value of the marginal product is the marginal product of the input multiplied by the market price of the output. VMPL = MPL  P

Copyright © 2004 South-Western The Value of the Marginal Product and the Demand for Labor The value of the marginal product (also known as marginal revenue product) is measured in dollars. It diminishes as the number of workers rises because the market price of the good is constant.

Copyright © 2004 South-Western The Value of the Marginal Product and the Demand for Labor To maximize profit, the competitive, profit- maximizing firm hires workers up to the point where the value of the marginal product of labor equals the wage. VMP L = Wage

Copyright © 2004 South-Western The Value of the Marginal Product and the Demand for Labor The value-of-marginal-product curve is the labor demand curve for a competitive, profit- maximizing firm.

Figure 3 The Value of the Marginal Product of Labor Copyright©2003 Southwestern/Thomson Learning 0 Quantity of Apple Pickers 0 Value of the Marginal Product Value of marginal product (demand curve for labor) Market wage Profit-maximizing quantity

Copyright © 2004 South-Western FYI—Input Demand and Output Supply When a competitive firm hires labor up to the point at which the value of the marginal product equals the wage, it also produces up to the point at which the price equals the marginal cost. (Price of Good) x (Marginal Product labor ) = wage rate

Copyright © 2004 South-Western What Causes the Labor Demand Curve to Shift? Output Price Technological Change Supply of Other factors

Copyright © 2004 South-Western THE SUPPLY OF LABOR The labor supply curve reflects how workers’ decisions about the labor-leisure tradeoff respond to changes in opportunity cost. An upward-sloping labor supply curve means that an increase in the wages induces workers to increase the quantity of labor they supply.

Figure 4 Equilibrium in a Labor Market Copyright©2003 Southwestern/Thomson Learning Wage (price of labor) 0 Quantity of Labor Supply

Copyright © 2004 South-Western What Causes the Labor Supply Curve to Shift? Changes in Tastes Changes in Alternative Opportunities Immigration